Ad valorem versus unit taxes: monopolistic competition, heterogeneous firms, and intra-industry reallocations |
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Authors: | Philipp J H Schröder Allan Sørensen |
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Institution: | 1. Department of Economics, Aarhus School of Business, Aarhus University, ?rhus, Denmark
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Abstract: | Real-world industries are composed from heterogeneous firms and substantial intra-industry reallocations take place, i.e.
high productivity firms squeeze out low productivity firms. Previous tax-tool comparisons have not included these central
forces of industry structure. This paper examines a general equilibrium monopolistic competition model with heterogeneous
firms and intra-industry reallocations. We show that the welfare superiority of ad valorem over unit taxes under imperfect
competition is not only preserved but amplified. The additional difference between the tools arises because unit taxes distort
relative prices, which in turn reduces average industry productivity through reallocations (the survival and increased market
share of lower productivity firms). Importantly, numerical solutions of the model reveal that the relative welfare loss from
using the unit tax increases dramatically in the degree of firm heterogeneity. |
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Keywords: | |
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